How much is Ben Bernanke worth?

John Nyaradi is Publisher of
Wall Street Sector Selector, a financial media site focused on news,
analysis and information about exchange traded funds and global financial and
economic developments.
John's investment articles have appeared in many online publications including
MarketWatch, Trading Markets, Money Show, Yahoo Finance, Investors Insight,
Fidelity, ETF Daily News, iStock Analyst and his interviews have appeared on
MarketWatch, Yahoo Finance's Breakout, National Business Talk Radio, Sound
Investing, and The Index Investing Show. His book, "Super
Sectors: How to Outsmart the Market Using Sector Rotation and ETFs", is
included among the Years Top Investment Books in the 2011 Stock Trader’s
Almanac.

As the "taper on" or "taper off" rhetoric continues, it's time for investors to consider how much Ben Barnanke has been worth and what the cost might be should "taper off" become the new paradigm.

During last week's testimony by Federal Reserve Chairman Ben Bernanke before the Senate Banking Committee, many committee members took the opportunity to thank the chairman for his years of noble service during a particularly difficult era for the American economy. The props resulted from widespread expectations that Dr. Bernanke would be retiring from the Fed in the near future. The chairman did nothing to dispel those rumors.

Although it is a bit early to grade Ben Bernanke on his performance — particularly with respect to the financial crisis and its aftermath — many commentators are toying with the hypothetical question of where stocks and bonds would be today without the intervention agenda implemented by the Fed chairman.

Once the Fed began its intervention after the financial crisis, it began purchasing what eventually became trillions of dollars worth of long-term Treasurys and mortgage-backed securities. With short-term interest rates lowered to near zero, the Fed's bond buying focused on long-term Treasurys. Most economists agree that this move drove investors from the safe haven of bonds to higher-risk investments (such as stocks) in the quest for better returns. As a result, stock prices became more inflated as demand increased.

During Dr. Bernanke's testimony before the House Financial Services Committee on July 17, Congressman Mick Mulvaney of South Carolina used a chart which depicted growth of the Fed's balance sheet as it related to the rise of the S&P 500 Index. When the Congressman asked the chairman if the stock market was addicted to quantitative easing, Dr. Bernanke responded that rising stock prices reflected the strength of the economy.

Others are less-willing to credit the economic recovery for the stock-market advance. Barclays' CIO Hans Olsen recently appeared on CNBC's Squawk Box and admitted that quantitative easing has inflated stock prices to a degree "that would make the stock market bubble of 2000 look like a day at the beach."

As we saw during the month following Chairman Bernanke's May 22 suggestion that the Fed would begin to scale back its bond buying "within the next few meetings" of the FOMC if the economy began to improve, both stocks and bonds sank. The S&P 500 fell more than 5% during that period, and the price of the 10-year Treasury note sank more than 4%. If the mere suggestion that the Fed's asset purchase program would slow by an unspecified amount at an unspecified time could cause such a shockwave, what would the consequences have been if the Chairman made a more definite statement — or worse yet — announced a cessation of quantitative easing?

The answer is that we would very quickly learn how the strength of the economy has little or nothing to do with the current prices of equities and, for that matter, Treasury securities.

On the other hand, this demonstrates that Dr. Bernanke's efforts have helped prevent the financial crisis and its aftermath from destroying the 401(k) plans and individual retirement accounts for millions of Americans — so far. The problem comes with the unwinding. The enhanced prices for equities resulted from lowering the value of the dollar — pushing more money into the stock market while simultaneously creating more demand for equities.

When the dollar is allowed to strengthen, equity prices will likely shrink — particularly because investors will know why — at which point they will probably head for the exits. The Fed's challenge going forward is to phase out quantitative easing in such a manner that all of the passengers will not run to the same side of the boat at the same time (as Pimco's Bill Gross likes to say) — causing it to heel and take on water.

So how much of a correction could the stock market be looking at should quantitative easing dry up and it turns out that the economy and earnings aren't strong enough to carry the freight?

Looking at a chart of the S&P 500 and a Fibonacci Retracement study, we can see that the effect of quantitative easing has been a virtually uninterrupted rise in the S&P 500 from approximately 700 to 1695, a gain of approximately 140% over the course of the last four-plus years.

As the chart depicts, a standard retracement could take the S&P into a range between 1071 and 1315, and so we can conclude that cessation of the Fed's easy-money programs could trigger a decline of between 22%-36%.

Of course, quantitative easing could really become "QE To Infinity," as markets and policymakers seem addicted to the sugar high of easy money. So far Ben Bernanke's plan has worked, and now it seems likely that the exit from QE will be up to someone else who will have to make sure the job gets finished without sinking global financial markets and the world's economy. While nobody can determine how much Ben Bernanke has really been worth, Wall Street Sector Selector remains in “yellow flag” status, expecting rocky conditions ahead.

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